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Thanks for these insightful comments, Danny. They touch upon a fundamental issue, worth exploring into some more detail.
But before responding to your question, let me first make a general remark about two fallacies that invariably pop up in different shapes and shades when discussing the role of innovation in growth and development.
The first fallacy is that growth through innovation is just about technological change resulting from ground-breaking discoveries often in the context of formal R&D programs. Innovation of course goes much beyond this and includes also nontechnological types of innovation and these types of innovation may apply to not just products but also processes and organizations. Innovation is also not just concerned with the creation of ideas that are completely new to the world. Equally (and, for growth, perhaps more) important is the diffusion of existing ideas that have been long established but may be new to a firm, an industry or even a country. Innovation through diffusion is a powerful source of productivity growth, but this is all too often insufficiently emphasized.
The second fallacy is that innovation can be separated from the accumulation of human and physical capital. This fallacy arises perhaps from the fact that innovation—hard as it is to conceptualize, measure and control—is not easily captured by the straightjacket of the four- or five-variable economy-wide production function, where the accumulation in the factors of production and the growth rate of total factor productivity are separated. While this separation is analytically convenient and useful for broad-brush assessments, the reality is that innovation itself depends on factor accumulation. For innovation to thrive, it therefore needs to be supported by a healthy level of investment in human and physical capital.
Turning to the question of whether innovation is essential to Malaysia’s high-income ambition, the short answer is yes. Let me amplify why by addressing the following three questions.
Can Malaysia squeeze additional growth momentum out of factor accumulation? Certainly. On physical capital accumulation, as documented in our November 2009 report, the share of private investment collapsed dramatically following the Asian financial crisis and, unlike most other countries in the region, it never fully recovered. While there are several reasons why investment shares should not be expected to fully recover to pre-crisis levels, the current level of investment appears to be low for a dynamically efficient economy and the current report suggest some reasons why this may be the case. On human capital accumulation, there is also scope for improvement. The skills issue is perceived by some 1,400 manufacturing and services firms as the number-one obstacle in consecutive World Bank investment climate assessments. We also know that, while labor force participation of Malaysian males is among the highest in the region, female labor force participation is among the lowest.
Will additional factor accumulation be sufficient to break through the glass ceiling between middle and high income? Not necessarily. All will depend on the type of factor accumulation. If the old ways of plain-vanilla accumulation measured by numbers is to be repeated, then the collateral benefits of economy-wide productivity growth are unlikely to materialize. Malaysia does not just need additions to the number of people or the stock of physical capital. To climb up the income ladder, it will be the skill, talent and entrepreneurship of the workforce and the quality of domestic and foreign investment that will determine the rate of success or failure in moving up the value chain.
Is innovation essential? Yes, but not just the narrow forms of innovation (where focusing on easy metrics may produce inferior results) and not just through total factor productivity growth but also on the back of better-quality human and physical capital. To put it bluntly in the terms of the debate in the 1990s, the fundamental driver of growth needs to shift from ‘perspiration’ to ‘inspiration’ and the economy needs to transform from ‘sweatshop’ to ‘smartshop’. Innovation—the successful exploitation of new ideas—holds the key to success in this transformation. The alternative—perspiration without inspiration—will undoubtedly produce some benefit of growth, but is a risky proposition given the increasingly intense competition. With other countries striding ahead and moving up the value chain (China being the case in point), standing still is an option but it is not a very good one. In the current environment, innovation is not just required for growth, it is also essential for survival in the global marketplace.